Fintech and digital innovation: the future of banking

“We have to have the mindset of a financial technology (fintech) company’; ‘We need to think and act like a 200-year old startup’; ‘If we don’t innovate, we’re toast.”

These statements from Australian bank CEOs highlight three strategic implications for the future of the banking industry. Firstly, technology disruption is quickly evolving the competitive landscape, lowering entry barriers for new players and creating new business models. Secondly, investment in digital innovation will be critical in delivering customer experiences that are being redefined by the likes of Uber and Airbnb. And thirdly, partnering with and/or sourcing capability from fintech startups and technology companies will form an important part of the response for established financial institutions, as they more aggressively pursue revenue growth, cost efficiency and risk-mitigation opportunities.

Fintech is one of the fastest-growing sectors in the global financial services industry, with total investment rising from US$100 million in 2008 to more than US$31 billion in 2016. In Australia, we have seen the number of fintech startups increase from less than 100 in 2014 to more than 530 today, with more than US$670 million invested in the fintech sector today (from US$50 million in 2012). While this growth has seen the emergence of fintechs that are seeking to directly compete with incumbent banks (the ‘carnivores’), with $30 billion of industry revenue estimated to be at risk of disruption over the next 5 years, there is an increasing number of fintechs looking to partner with or sell their services to financial institutions (the ‘herbivores’).

There are benefits for both parties in a collaborative model. Fintechs gain access to a range of important growth levers, such as customers, distribution, data, capital, experience, licences, a trusted brand and an ability to scale much more quickly. Alternatively, incumbents gain access to new ideas, solutions, capability, knowledge and potential investment opportunities, in new players that are typically focused on a specific problem or opportunity, and have significantly lower cost structures. It ultimately allows incumbents to be more agile and faster to market, as well as providing strategic optionality.

Factors reshaping the banking industry and fintech growth

There are several factors that are reshaping the banking industry and fuelling the growth of fintech – the accelerating pace of change; the proliferation of mobile devices and digital platforms; falling barriers to entry and greater competition; and a more supportive policy and regulatory environment for fintech innovators, each of which plays an important role. Above all, changing consumer behaviours and attitudes, led by the rising tide of millennials, and a move towards platform-based business models, will be the most fundamental driver of the industry’s evolution in the future.

Gen Y already makes up 22 percent of Australia’s population and will form 50 percent of the workforce in 5 years; therefore, they will be significant drivers of banking revenue in the not-too-distant future, and their priorities and preferences are distinctive. They rapidly embrace new technology, seek advice from alternative sources (for example, social media) and demand greater levels of personalisation, convenience and immediacy. They are also increasingly less loyal to their financial institutions. In a KPMG Australia study, 28 percent of gen Y professionals surveyed hold financial products with three or more institutions, compared to 11 percent last year. An enhanced customer experience is key to attracting and retaining this group. For banks, these attributes will be important to consider as banks evolve their future products and services to meet these needs.

In an industry traditionally dominated by large players, with historically product-centric operating models such as banking, the emergence of platform-based businesses in and outside of the sector will likely result in a shift in the balance of power towards platform providers and the end customer. Furthermore, as technology infiltrates every aspect of life, retail banks could become largely invisible to consumers, as banking activities become hidden – for example, by virtual assistants, like Amazon’s Alexa, which can fulfil daily personal and financial obligations, informed by data gathered from a fully connected way of life. The technologies that enable this scenario are all available today: advanced data analytics, voice authentication, artificial intelligence (AI), connected devices, application programming interface (API) and cloud technology.

In considering their responses, banks remain highly trusted and could develop ‘lifestyle layers’ to compete in the platform space, orchestrating ecosystems of fintechs and other providers themselves for consumers and small businesses. If banks are not leveraging these capabilities, they face being disintermediated by, and disaggregated behind, devices, services and ‘lifestyle platforms’ that manage more than financial services.

Clearly, the banking industry is not standing still. Banks, globally and in Australia, are increasingly recognising that investments in and collaboration with fintech startups and other technology companies offer a broader range of new ideas and possibilities. According to the Wharton Business School, ‘Disruptive innovations need not lead to an incumbent’s fall, despite prevailing academic theory arguing otherwise. Startups introducing disruptive technologies are more likely to end up licensing to incumbents, forming alliances or merging with market leaders rather than turning into rivals’.

There is no doubt that the banking industry of the future will look very different from what it looks like today. The landscape will be more competitive, more efficient and provide more customer choice. Banks will come under increasing competitive pressure unless they can leverage technology to cut costs, making them closer to leaner fintech operators. Agile incumbents that are efficient distributors or acquirers of leading fintech capability to meet adjacent customer needs have the potential to generate new sources of growth and value for customers.